RECENT DEVELOPMENTS IN CLASS ACTION
ADMINISTRATION AND SETTLEMENTS:
HAVE THEY GONE CRAZY OUT IN
DELAWARE?
KURT M. HEYMAN
kheyman@proctorheyman.com
MELISSA N. DONIMIRSKI
mdonimirski@proctorheyman.com
PROCTOR HEYMAN LLP
WILMINGTON, DELAWARE
Prologue: Cox Communications* and the “Kabuki Dance”
A controlling shareholder (the “Controller”) of a company proposes a going private
transaction by way of fully negotiated merger. On announcement of the proposed
merger, numerous stockholder lawsuits are filed challenging the fairness of the yetto-be negotiated merger.
The board appoints an independent Special Committee to consider and negotiate
the merger with the Controller. Once the lawsuits are filed, plaintiffs cease litigation
activity and wait for the outcome of the Controller-Special Committee negotiations.
The Controller and Special Committee proceed to negotiate directly. They reach a
deal on price and agree to make the deal subject to settlement of the outstanding
lawsuits. The Controller then presents this deal to the plaintiffs as a “best and final
offer” for settlement of the stockholder lawsuits. Plaintiffs counter for majority of
the minority approval to which the Controller agrees. Plaintiffs claim credit for the
pendency of the lawsuits leading to an improvement in the terms of the deal and are
rewarded with attorneys’ fees, which are paid by the Controller.
* In re Cox Commc’ns, Inc. S’holder Litig., 879 A.2d 604 (Del. Ch. 2005)
1
Why do defendants engage plaintiffs in this Kabuki dance? Because
Kahn v. Lynch Commc’n, Inc. 638 A.2d 1110 (Del. 1994), sets forth a
standard requiring that all mergers with a controlling stockholder be
subject to entire fairness review, which will not be dismissible on a Rule
12(b)(6) motion, making it economically more logical to settle rather
than litigate a Kahn lawsuit.
The settlement obtained by the Kabuki dance also provides the
Controller with broad releases from any future litigation relating to the
underlying transaction, which is also “the most effective
discouragement of appraisal claims.” (879 A.2d at 631.)
“The incentives on both sides maximize the likelihood of settlements
that result not from any case-specific efforts by the plaintiffs' lawyers,
but from the mutually livable outcomes generated when settlements
are tied to the financial results achieved by special committees.
Everyone gets happy…” (Cox, 879 A.2d at 633.)
2
The proposed Cox “Integrated Standard”
Vice Chancellor Strine proposed to integrate the review standards of Kahn and the In
re Siliconix Inc. S’holders Litig., 2001 WL 716787 (Del.Ch.) line of cases. The Siliconix
line of authority regulates a Controller’s attempt to take a corporation private through
a tender offer and subsequent back end merger, but permits avoidance of entire
fairness review if the tender offer is subject to approval by the minority shareholders
and the board is not involved in the tender.
The proposed integrated standard would permit both Kahn and Siliconix going-private
transactions to avoid entire fairness review if the transaction is (i) negotiated by an
independent Special Committee and (ii) approved by the majority of the minority.
Strine noted that the economics of the Kabuki dance make it irrational for defendants
to challenge Lynch through an appeal to the Delaware Supreme Court.
3
“I remember when, I remember I remember when I lost my mind.”
-- Gnarls Barkley, “Crazy” (2006)
Brinckerhoff v. Texas E. Prods. Pipeline Co., LLC, 986 A.2d 370 (Del. Ch. 2010)
The Court applied a high level of scrutiny when considering whether to approve a settlement
that would resolve a Cox Communications/Kahn going private transaction in addition to
previous derivative litigation that challenged certain insider transactions.
Concern over whether the settlement consideration adequately valued the derivative claims
caused the Court to review the settlement with “significant scrutiny.” (986 A.2d at 386.)
Additionally, the Court requested a supplementation of the record to include the Special
Committee’s valuation materials in order to review how the Special Committee valued the
derivative claims (Brinckerhoff v. TEPPCO, C.A. No. 4548 (Del. Ch. Oct. 12, 2010) (Transcript at
39-43)).
“Due regard for the protective nature of the stockholders’ class action [and to which I would
add derivative actions as well], requires the court, in these cases, to be suspicious, to exercise
such powers as it may possess to look imaginatively beneath the surface of events, which, in
most instances, will itself be well-crafted and unobjectionable.” (986 A.2d at 374.) (quoting
In re Fort Howard Corp. S’holders Litig., 1988 WL 83147 (Del. Ch.))
4
Brinckerhoff v. Texas E. Prods. Pipeline Co., LLC, 986 A.2d 370 (Del. Ch. 2010)
(continued)
On the expanded record, the Court found that the Special Committee had used
the derivative claims “as an effective negotiation tool to increase the Merger
consideration and obtain a fair result.” (Id. at 395.)
The Court reduced the attorneys’ fees from $19.5 million to $10 million, finding
that:“In pursuing the Derivative Action, plaintiffs’ counsel undertook real
contingency risk. Plaintiffs’ counsel did not take the case through trial, but did
engage in significant litigation efforts, including extensive document discovery
and four depositions. Once the parties shifted into Cox Communications mode,
the plaintiffs’ risk was substantially mitigated.” (Id. at 396.)
5
“I’m going off the rails on a crazy train!”
-- Ozzy Osbourne, “Crazy Train” (1981)
In re Revlon, Inc. S’holders Litig., 990 A.2d 940 (Del. Ch. 2010)
The Court questioned the adequacy of class counsel where counsel agreed to settle strong
claims for minimal consideration. The Court ultimately replaced lead counsel.
The case started out as a traditional Cox Communications case challenging a yet-to-benegotiated merger with a controlling stockholder. The merger entailed an exchange of
unlisted preferred stock for publicly traded common stock. Following negotiations with the
Controller, however, the Special Committee determined that it could not recommend the
merger when its investment advisor refused to issue a fairness opinion.
With no Special Committee recommendation, the controlling shareholder opted to launch a
tender offer on the same terms as the merger and with a majority of the minority condition.
The board authorized the tender offer but declined to recommend that shareholders tender.
In settlement negotiations, the plaintiffs obtained several additional concessions respecting
the form of consideration stockholders would receive.
6
In re Revlon, Inc. S’holders Litig., 990 A.2d 940 (Del. Ch. 2010) (continued)
Less than a majority of the minority shareholders tendered and the controlling shareholder
renegotiated the tender to waive the majority of the minority tender condition and to eliminate
most of the concessions obtained by plaintiffs. Plaintiffs agreed to the terms of the revised
tender offer and endorsed the settlement as reasonable and in the best interests of the
stockholders.
Additional shareholder lawsuits were filed, challenging the fairness of the final terms of the
revised tender offer and moving to consolidate all shareholder litigation.
The Court expressed skepticism of the value to shareholders of settlements that do not
significantly revise deal terms. “The resulting system involves little real litigation activity,
generates questionable benefits for class members, provides transaction-wide releases for
defendants, and offers a good living for the traditional plaintiffs’ bar.” (Id. at 959-60.)
In particular, the Court questioned plaintiffs’ willingness to endorse as reasonable and in the best
interests of the shareholders a tender offer that the board had refused to recommend and
subsequently agree to waive most of the concessions they had obtained, apparently simply to
permit the settlement to go forward. “If there were ever a test case for applying entire fairness
review to a tender offer, this one would fit the bill.” (990 A.2d at 956.)
7
In re Revlon, Inc. S’holders Litig., 990 A.2d 940 (Del. Ch. 2010) (continued)
The Court replaced lead counsel, citing concerns that “Old Counsel has acted only when
there was a dispute over control of the case and Old Counsel’s path to a fee.” (990 A.2d at
957.) The Court pointed to the lack of evidence that the old lead counsel had conducted
any meaningful assessment of the claims or investigation into the facts. Minimal discovery
was served but responses were never sought and old counsel acknowledged that, at the
time the settlement was negotiated, they had only publicly available information.
The Court questioned the accuracy of statements in the MOU “which appear designed to
lead the Court to believe that Old Counsel played a ‘substantial’ role in changes that seem
to have had very little to do with Old Counsel.” (Id. at 950.) The Court noted that it was
not apparent how plaintiffs had determined the fairness of the transaction, given that the
Special Committee’s advisors refused to issue a fairness opinion. The Court also
questioned the MOU’s assertion that Old Counsel had “conducted substantial factual and
legal research” noting that, at a minimum, plaintiffs had not used traditional discovery
tools to obtain information and that plaintiffs had only publicly available information at the
time the MOU was negotiated.
8
In re Revlon, Inc. S’holders Litig., 990 A.2d 940 (Del. Ch. 2010) (continued)
The Court ordered the New Counsel to conduct confirmatory discovery and
evaluate the settlement in preparing to present the settlement to the Court.
Furthermore, the Court ordered investigation into Old Counsel, including what
actions had been taken in negotiating the settlement, the degree of factual
and legal investigation, the number of hours expended, the identity and
qualifications of the unnamed financial advisor and the basis for the
determination that the settlement was fair.
Perhaps not surprisingly, the settlement was ultimately abandoned after New
Counsel was appointed.
9
“Let me go crazy on you!”
-- Heart, “Crazy On You” (1976)
Scully v. Nighthawk Radiology Holdings, Inc.,
C.A. No. 5890-VCL (Del. Ch. Dec. 17, 2010) (Transcript)
The Court ordered briefing for the purpose of investigating whether actions taken
by the parties to settle in Arizona were intended to circumvent the oversight of the
Court, and if “collusive forum shopping” was the cause, what remedies are available
to the Court.
Shareholder class claims were filed in both Delaware and Arizona challenging a
merger between Nighthawk and Virtual Radiologic Corp.
During a preliminary injunction hearing, the Court refused to enter the PI but
indicated that it regarded the process claims as strong and the disclosure claims as
weak. No proceedings had yet occurred in Arizona.
Following the hearing, the parties negotiated a disclosure-based settlement of the
claims and informed the Court that the settlement would be submitted to the
Arizona court for approval.
10
Scully v. Nighthawk Radiology Holdings, Inc.,
C.A. No. 5890-VCL (Del. Ch. Dec. 17, 2010) (Transcript) (continued)
Out of concern that the parties were seeking to submit the settlement to the Arizona
court based on the weak disclosure claims (as opposed to the strong process claims) in
an attempt to avoid scrutiny of a settlement with no monetary value to the shareholders,
the Court ordered additional briefing respecting the sudden move to Arizona. The Court
also ordered briefing on what remedies are available to the Court if “collusive forum
shopping” had occurred.
Finally, the Court appointed special counsel to represent the interests of the State of
Delaware in the briefing, and to evaluate harm caused to the State if “collusive forum
shopping” had taken place.
Special Counsel Report
The Special Counsel Report found that, while some actions taken by the parties gave rise
to suspicion, review of the negotiations revealed fairly typical arm’s-length negotiations.
11
Scully v. Nighthawk Radiology Holdings, Inc.,
C.A. No. 5890-VCL (Del. Ch. Dec. 17, 2010) (Transcript) (continued)
Special Counsel recommended a “best practice” of substantively involving Delaware
plaintiffs’ counsel in negotiations to avoid the appearance of impropriety, given the
Court’s focus on representative settlements. Special Counsel also recommended that
multijurisdictional parties keep all Courts informed of proceedings in the others. Special
Counsel also noted that “much self-policing among the bar has already occurred and will
continue to occur, supplemented by the continued careful consideration of settlements
by this Court…”
Following submission of the Special Counsel Report, the Court issued a letter ruling that
the Court was satisfied with the analysis of Special Counsel, that the Court had no
concerns about the conduct of any attorney in the matter, and that some of the Court’s
earlier statements unfairly cast defense counsel in a negative light. The Court stayed the
case pending completion of the Arizona litigation.
11
“Let’ go crazy! Let’s get nuts!”
-- Prince, “Let’s Go Crazy!”(1984)
In re Del Monte Foods Company S’holders Litig., 2010 WL 5550677 (Del. Ch.)
The Court applied the so-called Hirt factors in appointing lead counsel and lead plaintiff of
class action shareholder litigation.
In considering lead counsel’s ability to provide effective representation, the Court considered
at length the quality of pleadings filed, counsel’s experience with class action shareholder
litigation and associated track record.
The Court was particularly interested in successes achieved by counsel’s efforts and the
reliability of counsel’s submissions to the Court. The Court was critical of law firms that
claimed credit for outcomes achieved in a Cox Communications setting and indicated that
such statements created doubt about other assertions of success.
In considering lead plaintiff’s ability to represent the class, the Court considered the size of
the plaintiff’s holding, the ability of the plaintiff to provide oversight of counsel and whether
the plaintiff could create unnecessary vulnerabilities in the class (one of the proposed lead
plaintiffs did not clearly have standing).
12
“Son, they all must be crazy out there.”
-- Garth Brooks, “Night Rider’s Lament” (1992)
Implications for the Future
The Court is taking seriously its fiduciary responsibility for the class.
In lead counsel disputes, the Court will select the counsel it believes will best represent
the interests of the class. It will even remove and replace lead counsel for the class in
extreme cases.
Settlements will be closely scrutinized to determine whether the consideration is fair
and reasonable in exchange for the release of the claims involved. Such scrutiny
involves valuation of the claims being released.
The Court will consider carefully whether class counsel’s representation is vigorous and
the extent to which the outcome was a direct result of counsel’s efforts. Attorneys’
fees will be cut where counsel did not create value for the class.
If actions taken by the parties seem strange or unusual, the Court may investigate to
determine whether collusive or improper actions may be the cause.
13
“I’m crazy for lovin’ you.”
-- Patsy Cline, “Crazy” (1961)
The role of Delaware Courts as fiduciary when managing class action litigation has been long
established. There is really very little that is new about the recent decisions summarized herein.
The recent cases are best understood as a continuation of a traditional role that exists for the
benefit of absent class members.
Settlement
“Because of the fiduciary character of a class action, the court must participate in the
consummation of a settlement to the extent of determining its intrinsic fairness.” Rome v. Archer,
197 A.2d 49, 53 (Del. 1964) [Patsy Cline era]
“The court's function is to consider the nature of the claim, the possible defenses thereto, the
legal and factual circumstances of the case, and then to apply its own business judgment in
deciding whether the settlement is reasonable in light of these factors.” Polk v. Good, 507 A.2d
531, 535 (Del. 1986) [Heart was still rocking]
14
“If, in the light of these matters, the Court of Chancery approves the settlement as reasonable
through the exercise of sound business judgment, its function as the so-called third party to the
settlement has been discharged.” Nottingham Partners v. Dana, 564 A.2d 1089, 1102 (Del. 1989)
[Prince era]
Representation
A plaintiff who becomes a class representative assumes a fiduciary role with respect to the absent
class members. Tuckman v. Aerosonic Corp., 1980 WL 272833, *2 (Del. Ch.) [Ozzy Osbourne era]
“The requirement of adequate representation also includes an element of adequate counsel for
the plaintiffs.” In re Best Lock Corp. S’holder Litig., 845 A.2d 1057, 1093 (Del. Ch. 2001) [The Artist
Formerly Known as Prince era]
Fees
“Heightened judicial scrutiny applies to the approval of fee applications in class action
settlements because once a fee petition is filed and the attorney becomes a claimant against the
fund created for the benefit of the class, fiduciary responsibility for the class shifts from the
attorney to the trial court and the trial court has the duty to award fees with moderation and a
jealous regard for the rights of class members.” PaineWebber R & D Partners II, L.P. v. Centocor,
Inc., 2000 WL 130632 (Del. Ch.) [Garth Brooks era]
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